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David Merkel is an investment professional, and like every investment professional, he makes mistakes. David encourages you to do your own independent "due diligence" on any idea that he talks about, because he could be wrong. Nothing written here, at RealMoney, Wall Street All-Stars, or anywhere else David may write is an invitation to buy or sell any particular security; at most, David is handing out educated guesses as to what the markets may do. David is fond of saying, "The markets always find a new way to make a fool out of you," and so he encourages caution in investing. Risk control wins the game in the long run, not bold moves. Even the best strategies of the past fail, sometimes spectacularly, when you least expect it. David is not immune to that, so please understand that any past success of his will be probably be followed by failures. Also, though David runs Aleph Investments, LLC, this blog is not a part of that business. This blog exists to educate investors, and give something back. It is not intended as advertisement for Aleph Investments; David is not soliciting business through it. When David, or a client of David's has an interest in a security mentioned, full disclosure will be given, as has been past practice for all that David does on the web. Disclosure is the breakfast of champions. Additionally, David may occasionally write about accounting, actuarial, insurance, and tax topics, but nothing written here, at RealMoney, or anywhere else is meant to be formal "advice" in those areas. Consult a reputable professional in those areas to get personal, tailored advice that meets the specialized needs that David can have no knowledge of.

Skewed Incentives

May is a tough month for me, because I have to submit reports for the nonprofits that I work with, and this year is worse, because I have a moderate injury that I need to see a doctor about, but can’t until next week, because of the schedule.

But I do want to say a few things about the JP Morgan news. First, JP Morgan should be broken up, whether state by state, or by Federal reserve district, with an investment bank spun off as well.

Second, after we have been through 2008, why do we care about a piddling $2Billion+ loss? JP Morgan’s balance sheet can handle far more than that, and come back kicking.

Third, there are a lot of people who are mindlessly asking for the reinstatement of Glass-Stegall, without realizing that the repeal had little to do with the crisis. Most of the losses at banks sprang from bad lending on residential mortgages, not trading. Also, if regulators had been more fastidious about asset quality and leverage, it also might not have happened, but who dares to oppose a boom?

My point of view is that states are better at regulating financials than the federal government. It is far harder to co-opt 50 regulators than one.

Decentralized government, where power is limited, is far harder to corrupt than centralized governments like India, China, Russia, Greece, etc.

Fourth, when a bank engages in a complex trade, and is a large portion of the market, it is asking for trouble. Companies have problems when they become the market for financial promises. Markets work well when there are a large number of players, with no one dominating. Financial markets with a dominant player have a problem because it becomes difficult for the dominant player to discern the right price. They don’t want to set it too low, because it makes their own financials look bad. That skewed incentive can harm economic truth, and the company as well.

Being a monopolist or an oligopolist is not as easy as the textbooks would say, at least for long-term transactions. When there is no free market to validate your pricing against, how does an oligopolist come up with an economic price? It can’t do so.

We get on shaky ground when anyone becomes dominant in a market of promises. Initially the accounting is flexible enough that losses do not occur on bad lending, but eventually the bad/negative net cash flows crush the firm. This is why I never invest in novel financial companies.

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About David Merkel

David J. Merkel, CFA, FSA, is a leading commentator at the excellent investment website RealMoney.com. Back in 2003, after several years of correspondence, James Cramer invited David to write for the site, and write he does — on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, and more. His specialty is looking at the interlinkages in the markets in order to understand individual markets better.
David is also presently a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. He also manages the internal profit sharing and charitable endowment monies of the firm.
Prior to joining Hovde in 2003, Merkel managed corporate bonds for Dwight Asset Management. In 1998, he joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life.
His background as a life actuary has given David a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that David will deal with in this blog.
Merkel holds bachelor’s and master’s degrees from Johns Hopkins University. In his spare time, he takes care of his eight children with his wonderful wife Ruth. View all posts by David Merkel →